Edited version of private ruling

Authorisation Number: 1011736038915

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Ruling

Subject: legal expenses

Question 1

Are you entitled to a deduction for legal expenses incurred in relation to proceedings commenced prior to termination relating to your transfer?

Answer

Yes.

Question 2

Are you entitled to a deduction for legal expenses incurred in relation to your unpaid bonuses and annual leave?

Answer

Yes.

Question 3

Are you entitled to a deduction for legal expenses commenced prior to termination in relation to a breach of good faith, trust and confidence and fair treatment by your employer?

Answer

Yes.

Question 4

Are you entitled to a deduction for legal expenses incurred in relation to your claim for unlawful termination or reinstatement?

Answer

No.

Question 5

Are you entitled to a deduction for legal expenses incurred in relation to your loss of future earnings?

Answer

No.

Question 6

Are you entitled to a deduction for legal expenses incurred in relation to remedies being sought for your stress, anxiety and medical costs?

Answer

No.

Question 7

Are you entitled to a deduction for legal expenses incurred in relation to the imposition of a penalty on your previous employer following your termination?

Answer

No.

Question 8

Are you entitled to a deduction for legal expenses incurred in relation to your unpaid superannuation entitlements?

Answer

No.

Question 9

Are you entitled to a deduction for legal expenses incurred in relation to your appeals to the Full Federal Court or High Court?

Answer

No.

Question 10

Are you entitled to a deduction for the full amount of legal expenses incurred in relation to suing your original solicitor?

Answer

No.

Question 11

Are you entitled to a deduction for a portion of your legal expenses incurred in relation to suing your original solicitor?

Answer

Yes.

This ruling applies for the following periods

Year ended 30 June 2008

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commenced on

1 July 2007

Relevant facts

The arrangement that is the subject of the Ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· the application for private ruling,

· statement of claims,

· court documents, and

· further information dated XX 2011.

You were an employee.

You began to encounter a number of difficulties in your work through the lack of support provided by management.

You applied for an internal position. You contend that you were offered and accepted the role. The position was similar to your previous position.

Your employer states that you were not actually offered the position, however they did advise you that they were proposing to offer you the position.

You were harassed and bullied by your manager to stay in your former position and not accept the new role. The manager made a number of telephone calls to you, some of them late at night and after normal business hours.

You sent an email to your manager asking him to stop telephoning you in relation to the matter of your transfer.

Your manager phoned you again.

You allege that the manager threatened that he would end your career if you did not stay in the former position.

Your employer withdrew the new position that had previously been offered. You were advised that the new position was no longer available due to restructuring.

Your requests to commence in the new role were refused.

The position was subsequently readvertised.

You initiated a complaint concerning these matters.

During your employment you consistently performed very well.

Without consulting you, your performance rating was downgraded. Your manager advised that an aspect of your work needed improving. The downgrade would ensure you would not be successful in obtaining another position within the organisation.

You were distressed by the employer's actions and requested an internal review. You advised that the review was flawed.

You started legal proceedings in the Federal Court.

During the court proceedings it was agreed that you be paid your base salary but not actually attend work.

The case was dismissed.

You appealed to the Full Federal Court and were unsuccessful.

The matter was then appealed to the High Court.

You incurred legal fees.

You have records of your invoices and payments made in respect of these legal fees.

An amount of your legal fees related to suing your original solicitor.

You sued your original solicitor, as the agreement was on a no win, no fee basis. You terminated their services and subsequently received an invoice for legal fees. As a result of legal action, the original invoice was withdrawn.

You sought legal advice in relation to:

· a transfer to the new position, and a breach of express agreement between you and your employer,

· the payment of your bonuses and annual leave under the contract,

· the payment of superannuation entitlements as per your contract,

· a breach of the implied terms of good faith, trust and confidence by your employer,

· breaches of section 1317AC of the Corporations Act 2001 (victimisation prohibited),

· breaches of Fair Treatment Review Policy,

· unlawful termination,

· Privacy Act breaches,

· remedies for loss of future earnings, damages for stress and anxiety arising from breaches of contract, medical expenses, compensation and imposition of a penalty under the Workplace Relation Act.

The implied terms of your employment contract included a good faith term and a trust and confidence term.

For the year ended 30 June 2008, you earned bonuses.

You received the bonuses after the notice of motion was filed.

You were later terminated by your employer after the court reversed the undertaking to keep you employed during court proceedings.

You have not received any reimbursement for the legal expenses incurred and do not have any insurance that will cover these costs.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1.

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for a loss or an outgoing to the extent to which it is incurred in gaining or producing assessable income, except where the loss or outgoing is of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining assessable income or, in other words, of an income-producing expense (Lunney v. FC of T; (1958) 100 CLR 478), 

· there must be a nexus between the outgoing and the assessable income so that the outgoing is incidental and relevant to the gaining of assessable income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47), and

· it is necessary to determine the connection between the particular outgoing and the operations or activities by which the taxpayer most directly gains or produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v. FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

For legal expenses to constitute an allowable deduction, it must be shown that they are incidental or relevant to the production of the taxpayer's assessable income or business operations. Also, in determining whether a deduction for legal expenses is allowable under section 8-1 of the ITAA 1997, the nature of the expenditure must be considered (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) 3 AITR 436; (1946) 8 ATD 190). The nature or character of the legal expenses follows the advantage that is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Legal expenses are generally deductible if they arise out of the day to day activities of the taxpayer's business (Herald and Weekly Times Ltd v. Federal Commissioner of Taxation (1932) 48 CLR 113; (1932) 39 ALR 46; (1932) 2 ATD 169 (the Herald and Weekly Times Case)) and the legal action has more than a peripheral connection to the taxpayer's income producing activities (Magna Alloys and Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276).

In FC of T v. Rowe (1995) 31 ATR 392; 95 ATC 4691, the taxpayer, an employee, was suspended from normal duties and was required to show cause why he should not be dismissed after several complaints were made against him. A statutory inquiry subsequently cleared him of any charges of misconduct or neglect. The court accepted that the legal expenses incurred by the taxpayer in defending the manner in which he performed his duties, in order to defend the threat of dismissal, were allowable. Since the inquiry was concerned with the day to day aspects of the taxpayer's employment, it was concluded that his costs of representation before the inquiry were incurred by him in gaining assessable income.

Transfer to new position

Expenditure incurred by an employee in applying for a promotion will generally be deductible under section 8-1 of the ITAA 1997 provided it is not capital, private or domestic in nature and it is objectively likely to lead to an increase in the employee's assessable income without effecting a change in the employee's current income earning activities (Taxation Determination TD 93/175).

In your situation, your incurred legal expenses in relation to a transfer to a new position, doing similar duties as in your previous position. The associated legal expenses were a consequence of defending your rights under your current employment agreement. It is considered that your expenditure on legal expenses was a consequence of your day to day activities as an employee from which you derived assessable income. Therefore the associated legal expenses incurred for actions taken prior to termination in relation to a transfer are deductible under section 8-1 of the ITAA 1997.

Please note, that the legal action taken after your termination is not considered to be sufficiently connected to your day to day income earning activities and are not an allowable deduction.

Bonus, annual leave and future earnings

Legal expenses incurred in recovering salary or wages are considered to be of a revenue nature and therefore deductible under section 8-1 of the ITAA 1997.

Similarly, legal expenses incurred in recovering unused annual leave are generally allowable as they directly relate to gaining or producing assessable income.

In your case you incurred legal expenses in relation to unpaid bonuses and annual leave that you would normally derive. It was agreed that you would not attend work during the court proceedings and as a result were unable to receive the commissions that you had previously earned in your employment position. It is considered that the associated legal expenses in relation to your unpaid bonuses and leave payments related sufficiently to the earning of your assessable income and are therefore deductible under section 8-1 of the ITAA 1997.

Breach of contract

A portion of your legal expenses related to your employment contract you had with the CBA and the implied terms of good faith, trust and confidence by your employer.

Taxation Ruling TR 2000/5 outlines the Commissioner's views on the costs incurred in preparing and administering employment agreements. A deduction is allowed for an employee for costs associated with settlement of disputes arising out of an existing employment agreement including the cost of representation. An employment agreement is a reference to an agreement between an employee and an employer regarding employment.

In your case, you allege that your employer's actions hindered the performance of your day to day employment duties and that management did not support you in your work and the requested internal review was not carried out as per the existing policy.

The activities to which the breaches related arose as a consequence of the performance of your duties when you were employed. It is considered that the disputes in the above matters during your employment are sufficiently connected to your income earning activities as an employee and are not capital or private in nature. Therefore, the associated action and legal expenses incurred in relation to your employer's breach of contract are an allowable deduction. Similarly, the legal action relating to the breaches under the Privacy Act and section 1317AC of the Corporations Act 2001 are sufficiently related to your assessable income and are an allowable deduction.

However, after your termination, your employment agreement no longer existed. Therefore disputes happening after termination do not arise out of an existing employment agreement and as such are not directly related to your assessable income. As such, the legal expenses are not deductible under section 8-1 of the ITAA 1997.

Termination, reinstatement and loss of future earnings

Taxation Determination TD 93/29 states: 

If the legal action goes beyond a claim for a revenue item such as wages, and constitutes an action for a breach of the contract of employment, the legal costs would not be deductible because they are capital in nature. For example, legal expenses relating to an action for damages for wrongful dismissal are not deductible.

The Courts, Boards and Tribunals have consistently held that the legal expenses incurred by taxpayers in defending themselves against dismissal from their employment are of a capital nature unless they are defending the way they carry out their day to day employment duties. This is because:

· the legal expenses can be regarded as having been incurred once and for all, and

· the advantage sought to be gained is the preservation of the taxpayers employment.

For example, in Case L26 79 ATC 126, a majority of the Board of Review No. 1 held that legal expenses incurred by a school teacher in appealing to a statutory board against her dismissal were not deductible.

Claims for costs incurred in appealing against another person's appointment to a position for the purpose of gaining promotion have also been consistently denied by Boards of Review as being capital in nature. In 10 CTBR (NS) Case 102, the taxpayer, a police constable, made several appeals against the promotion of other officers to the rank of sergeant. He claimed a deduction for legal representation at the hearing of one of these appeals. It was held, disallowing the taxpayers claim, that although the expenditure was incurred in gaining or producing assessable income (because, on the facts, it was more than likely that his promotion, but for the appeals would have been overlooked), it was expenditure of a capital nature and therefore not deductible under the general deduction provision.

In your situation, a portion of your legal expenses related to your unlawful termination claim and compensation for the loss of your employment position. Legal action was also taken to have your employment position reinstated and to receive compensation for loss of future earnings.

Legal expenses incurred in preserving employment are not deductible as they are considered to provide an enduring advantage and are therefore capital in nature. The advantage sought by you in undertaking the action is the restoration of a capital asset, that is, your means of producing income. As such, the character of the legal expenses associated with this action are considered to be capital in nature and the expenses are not deductible under section 8-1 of the ITAA 1997 (Case Y24 91 ATC 268; AAT Case 6942 (1991) 22 ATR 3184).

Damages for stress and anxiety and medical costs

Medical expenses are generally regarded as private expenses. Additionally it is a long standing principle that a taxpayer does not satisfy section 8-1 of the ITAA 1997 merely by demonstrating some casual connection between the expenditure and the derivation of income. What must be shown is a closer and more immediate connection. The expenditure must be incurred in gaining or producing your assessable income (Lunney v Commissioner of Taxation (1958) 100 CLR 478). These principles have been affirmed by the High Court in Commissioner of Taxation v Payne [2001] HCA 3.

The deductibility of the expenses can also depend on whether the claims would have resulted in assessable income. Reimbursement of medical expenses or a payment for personal injury is not generally regarded as assessable income.

In your case, the legal expenses incurred in relation to your stress, anxiety and other medical costs do not have the required nexus with the derivation of assessable income and are of a private nature. Therefore, the associated legal expenses are not an allowable deduction under section 8-1 of the ITAA 1997.

Imposition of a penalty in relation to your termination

You sought an imposition of a penalty under the Workplace Relations Act in relation to your termination of your employment and the penalty imposed to be payable to you.

The imposition of a penalty on your former employer does not relate sufficiently to the earning of your assessable income. Although you also seek this payment to be made to you, such a payment in relation to your termination is generally regarded as being capital in nature. Consequently no deduction is allowable under section 8-1 of the ITAA 1997 for the legal expenses incurred in relation to this matter.

Superannuation contribution

Mandatory employer superannuation contributions do not form part of your assessable income. They are paid as a requirement of the Superannuation Guarantee (Administration) Act 1992. Although you may have suffered a loss as a result of the non payment of these contributions the loss cannot be said to be a loss or outgoing incurred in order to earn your assessable income. The amount of your assessable income is not affected by the non payment of superannuation employer contributions.

In your case part of your legal costs related to recovering unpaid superannuation payments. As the superannuation payments are not considered part of your assessable income it cannot be said that the legal expenses were incurred in the process of deriving assessable income. As such you are not entitled to a deduction under section 8-1 of the ITAA 1997 for the associated legal expenses.

Legal action after your termination

After your termination, you continued legal action and appealed to the Full Federal Court and later to the High Court. As you were no longer an employee and there was no current employment agreement, the legal action taken is not considered to be sufficiently connected to your income earning activities as a bank employee. Furthermore, as highlighted above, action taken in relation to your termination is capital in nature. Therefore the legal expenses relating to action taken after termination is not deductible under section 8-1 of the ITAA 1997.

Suing your original solicitor

Action taken by your original solicitor included the issues relating to the breach of employment contract, restraining your employer from terminating your employment, damages and costs.

As highlighted above, some of this legal action is related to your income earning activities as an employee and other aspects relate to capital and private aspects. Consequently, suing your original solicitor in relation to the invoice raised also relates partly to deductible legal action and partly to non-deductible legal action. Therefore only the relevant portion of the associated legal expenses incurred in suing your original solicitor is an allowable deduction.

The portion of the legal costs incurred in suing your original solicitor that relate to the breaches of employment contract are considered to be sufficiently connected to your assessable income. However, the portion that relates to your employment termination, damages and costs relating to your stress, anxiety and medical costs are not sufficiently related to your assessable income and are capital or private in nature. Therefore the relevant portion of the associated expenses are not an allowable deduction.

Apportionment of expenses

As your legal expenses are not fully deductible, you will need to apportion the expenses using a reasonable basis. Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

Where legal expenses are not broken up into the relevant parts by your solicitor, you will need to calculate the deductible portion. One way to apportion your expenses is according to the dollar value of the assessable amount as compared to the total amount being sought. The relevant percentage that relates to your assessable income can then be applied to the legal expenses incurred.